What happened in the stock/bond markets last week?

Conclusions: The market fell last week. We haven't said that very much this year but it's true. The Dow only fell 0.09% but the S&P 500 fell 1% and the Russell 2000 small cap index fell almost 3%. Strangely, five times as many stocks hit new highs as new lows while 1000 more stocks fell than rose. Transportation and basic material stocks led the decline while more defensive securities are becoming more attractive. It has been a long time since we've seen telecom and utility stocks lead the market.

Earnings guidance has not been strong recently. Morgan Stanley reports that recently negative earnings pre-announcements for the first quarter of 2013 have outnumbered positive pre-announcements by 3.5 to 1. The average since 2005 has been 2.3. The last time this ratio was this high was in the third quarter of 2007.

Doug Short points out that the Cyclically Adjusted P/E ratio is now higher than 87% of its history. Ominously, the remaining 13% of higher valuations includes the Tech Bubble and the 1929 Peak. We have already surpassed prior bull market valuation peaks reached in 1906, 1936, and 1968. Indeed, our research has shown that subpar stock returns can be expected when the CAPE ratio is greater than 20 as it is now. This is not to say that stocks must decline, rather that this is not the start of a new bull market and active management will be necessary to achieve good risk adjusted returns going forward.

Sentiment has been growing more bullish as even retail investors are jumping on the market rally. Many sold out after the market low in 2009 and now are having a hard time justifying 0% returns in money market accounts. Our Fed, the European Central Bank and the Japanese Central Bank are all pushing investors into higher risk assets through easy money policies. Unfortunately, even as this policy has helped stocks, it hasn't righted the economic ship. Eventually stocks reflect the underlying economic value of businesses and we may have gotten ahead of real values.

Warren Buffet talks about the "Natural juice of capitalism" which pulls the economy forward. Reports this last week show a very diluted "natural juice." Both the service and manufacturing areas have seen reversals and new orders, apart from aircraft, are anemic. The continued weakness in employment and the record levels of citizen dependency on government assistance further illustrate the ineffectiveness of government juicing.

Our leading indicators have finally edged out of the neutral camp into a slightly negative posture. However, they have been joined by the vast majority of our coincident indicators. After a 23% rally from last June, we think the market is peaking and starting to offer more risk than reward. We may have another bounce or two left, but we need to begin shifting our focus to preserving capital. As such, we will start to reduce equity levels in overinvested accounts.

Conclusions: Last week, long term U.S. Treasury Bonds were up 4% while High Yield bonds were only up 0.1%. U.S. Treasury rates declined each day with the exception of Tuesday. We have been pointing out the benefits of Bonds in recent studies. Our founder, Dr. James, reiterated those comments on CNBC early last week and indeed, we saw the Bond market respond positively to the weakness in stocks.

Commodities were hit hard last week. Oil declined 2.74%, gasoline declined almost 8%, and corn declined almost 10%. The U.S. Dollar strengthened over 3.4% against the Japanese Yen and weakened slightly against the Euro and the Pound as the focus was on Japan.

The U.S. Employment report was a disappointment. The headline number of jobs created was 88,000 but this was below even the lowest economist estimate. The unemployment rate dropped to 7.6% but only because 660,000 Americans stopped looking for a job. The percentage of Americans participating in the workforce is now back to 1979 levels. Since January 2009, only workers 55 and older have seen a net increase in jobs, workers between the ages of 16 and 54 are still short almost 3 million jobs.

Unfortunately, ECRI reports that if you ignore seasonal adjustments, the Year-Over-Year (YOY) change in Total Nonfarm Payroll Employment and Total Household Survey employment are running at 19 and 18 month lows respectively. In their words, "Quite simply, U.S. job growth is worsening, not getting better."

The Bank of Japan (BOJ) has been in the news recently for actions that George Soros called "dangerous" and could cause an "avalanche" in their currency. The BOJ announced that they are going to effectively double their monetary base by the end of 2014 in order to "stimulate" the economy. The problem is, they've been trying this approach for decades and it hasn't worked.

Japan is trying to stimulate the economy by weakening their currency and increasing asset prices. The problem is their central government debt is 20 times their central government tax revenues. If interest rates increase by a couple of percent (as investors demand additional compensation for the likely depreciation in the Yen) their entire government budget will be needed to pay the interest on their debt.

Our bond indicators have been favorable for many weeks and they strengthened again this past week. We would continue to hold high quality bonds with moderate durations.

Want to Vote on this Content?! No WSO Credits ?

Sorry, you need to login or sign up using one of the blue buttons below in order to vote. As a new user, you get 3 WSO Credits free, so you can reward or punish any content you deem worthy right away. See you on the other side!

Want to Vote on this Content?! No WSO Credits ?

Sorry, you need to login or sign up using one of the blue buttons below in order to vote. As a new user, you get 3 WSO Credits free, so you can reward or punish any content you deem worthy right away. See you on the other side!

To unlock this content for free, please login / register below.

Connecting helps us build a vibrant community. We'll never share your info without your permission.
Sign up with email or if you are already a member, login hereBonus: Also get 6 free financial modeling lessons for free ($200+ value) when you register!

Want to Vote on this Content?! No WSO Credits ?

Sorry, you need to login or sign up using one of the blue buttons below in order to vote. As a new user, you get 3 WSO Credits free, so you can reward or punish any content you deem worthy right away. See you on the other side!

2016 Full-time IB Recruiting Timeline MegathreadIt's that time of year again, folks. Time to polish those resumes, fire up the LinkedIn and WSO search functions, and bug the hell out of the career advisers at your schools. It's recruiting time!
We are all looking for information on timelines and deadlines for every bank...

Cost Estimators: The Bankers of the Construction IndustryRecently guys I have started a career in the construction industry as a project manager and cost estimator for a local company (boutique) and have seen the underlying similarities to the bankers of the financial world.
It's also a career most finance and business guys haven't heard...

The ‘Business Cycle’ frameworkThis post is a follow-up to <a href="http://www.wallstreetoasis.com/blog/stop-reading-the-news-thoughtlessly-and-develop-a-macro-framework">one of my earlier posts, ‘Stop reading the news thoughtlessly and develop a macro framework’</a> which had generated some interest...

Why I Enjoy Networking with CandidatesI thought I'd write a networking post from a different perspective. We often see advice on WSO from people who are undergrads or recent hires with advice on how to network into the industry (good fresh perspectives from people who have recently navigated "the system"). I wanted to...

2016 Summer Analyst IB Recruiting Timeline Megathread<em>Mod Note (Andy): Make sure to bookmark this page as this will be the cumulative thread for 2016 SA <span class='keyword_link'><a href="http://www.wallstreetoasis.com/finance-dictionary/what-is-investment-banking-division-IBD">IBD</a></span>...

CFA Results - 2015Today is the big day we've been waiting for/dreading since early June, when we peeled out of the testing center parking lots, burned our books, and went off to get drunk with our long lost friends.
Level I & II results will be released via email today after 9:00 A.M ET. Level III...

McKinsey Who?Stumbled across this Forbes article from 1999 (link at bottom of post). When reading the first few paragraphs, you could easily think it was written yesterday (aside from the salary #'s). Makes the dotcom bubble of yore feel eerily familiar....
[quote]" <strong>7/26/1999...

Forum Topics

The growing perpetuity calculation in DCFHey, guys. I am a pre-MBA student. I studied one corporate finance class in law school so my question may seem too plain and simple. I was reading the DCF and noted that the calculation of the...

7 Things I Learned While Running a BusinessThought some of you may enjoy reading this. For the last 1-2 years, I've been running an editing service as a side gig. I probably won't operate it for too much longer because my regular job takes...

Transitioning from Operations to Asset Management I'm a recent finance graduate from a Canadian University, and graduated this year (3.1/4.0 GPA). I'm currently working at a large investment management/custody bank in investment servicing for mutual...

From generalist to consumer retailHi, I wold like to move from a generalist M&A boutique into a firm focused on consumer and retail. Can you suggest me any publication , book, modeling course to gain the knowledge to get prepared...

Summer internships in AMHi I would like to know how the recruitment process is in AM for summer (I am interested in London) and what typical part of interns get a FT offer after the summer

Soho (NYC) SubletTo anyone in need of an apartment / roommate, I've got a furnished bedroom in my apartment available. Shoot me a PM if interested. The Craigslist post below has the details.http://newyork....

Why I Enjoy Networking with CandidatesI thought I'd write a networking post from a different perspective. We often see advice on WSO from people who are undergrads or recent hires with advice on how to network into the industry (good...

CFAIf working in commodities which is becoming streamlined and narrowed as a broker / trader, how valuable will the CFA be. Understand its v broad therefore it would provide an in depth financial...

Consulting vs Tech Industry careerLooking for impartial career advice for a 24 yo needing to make a big life decision in the next couple of months.
Options I am considering now:
1.Stategy consulting in the City at a 2nd tier or...

West Michigan Undergrad SeniorHello Wall Street,
I am a little torn as to how to map out my final year as an undergrad at a non-target midwest state school. I will be beginning my senior year in exactly 29 days from this post. My...

RejectionMod Note (Andy): Make sure to check out the comment inside the post by @M- Weintraub
So, it's been a while since I've provided content to this wonderful website (sorry Patrick). But, I figure now...